Question

A stock has an expected return of 11.6 percent, its β is 0.91, and the risk-free rate is 5.8 percent. What μst the expected return on the market be? Note: Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.

a) 7.84%
b) 12.68%
c) 14.75%
d) 17.20%

Answer 1

Using the Capital Asset Pricing Model (CAPM), the expected return on the market is calculated to be 12.17%, which is closest to option b) 12.68%.

Step-by-step explanation:

To calculate the expected return on the market, we use the Capital Asset Pricing Model (CAPM), which is represented by the formula:

Expected Return of the Stock = Risk-Free Rate + Beta * (Expected Market Return - Risk-Free Rate)

By plugging in the known values and rearranging the equation to solve for the Expected Market Return, we get:

11.6% = 5.8% + 0.91 * (Expected Market Return - 5.8%)

We can then solve for Expected Market Return:

Expected Market Return = (11.6% - 5.8%) / 0.91 + 5.8%

Expected Market Return = 5.8% / 0.91 + 5.8%

Expected Market Return = 6.3736% + 5.8%

Expected Market Return = 12.1736%

After rounding to two decimal places, the Expected Market Return is 12.17%.

Therefore, the closest answer from the provided options is b) 12.68%